Studying Soros

The 13F provides data on the positions held as of end 2013 by the fund that manages George Soros’s family money. One particular position attracted a lot of attention.

It was reported that more than 10 per cent of the notional value of the portfolio was invested in put options on the S&P 500 and that this position had been significantly increased during the quarter.

This news leads to two obvious questions. Firstly, does the existence of the large put position mean that Soros is bearish on the US stock market? Secondly, if so, what justifies the negative outlook?

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My answer to the first question is ‘not necessarily’. A put option is a derivative that delivers money when the price of the underlying asset on which it is written falls to a level below a predetermined exercise price. Thus, in this case, the put position will deliver money when the S&P 500 drops below the exercise level. That immediately sounds bearish, right? Well, not exactly. One cannot look at this position in isolation from the rest of Soros’s portfolio. If the rest of the portfolio has positive exposure to the US stock market, then the put position starts to sound like a classic hedging strategy.

Essentially, Soros may just be buying insurance against the possibility of a fall in US stock markets. Let us assume that, excluding the put, Soros’s portfolio is net long the US stock market.

Indeed, the 13F filing that informed us of the put position also shows some chunky long positions in US stocks. Then if, for whatever reason, the US stock market was to drop, the put position would tend to deliver positive cashflow at precisely the same time as the rest of the portfolio was likely to be delivering negative returns. In the event that the US stock market rose, the put option would expire worthless and the rest of the portfolio would deliver positive returns. So the put hedges the downside stock market risk while not eliminating upside potential. This is exactly the same strategy homeowners pursue when buying insurance against their house burning down (that is, they spend a small amount of cash today such that, in the event of a disaster, some or all of their losses are mitigated). It is also worth noting that the put may be used to (imperfectly) hedge other risks that are positively correlated with US stock market risk.

So the answer to our first question is that it is not clear that the existence of the put position means that Soros believes the US market is due for a drop soon. But, let us put this point aside for now. Let us assume that the negative exposure to the US stock market that the put delivers is larger than the positive market exposure of the rest of his portfolio such that, net, he has indeed taken a negative view on the US stock market. Add to this the fact that the put position has been increased so dramatically quarter on quarter and it seems worth devoting some time to thinking about factors that might cause one to be bearish about US stock markets.